Accounting Standards Update 2018-12
Targeted Improvements to the Accounting for Long-Duration Contracts Issued by Insurance Companies
On August 15, 2018, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) to improve financial reporting for insurance companies that issue long-duration contracts such as life insurance and annuities.
The objective of the ASU is to improve, simplify, and enhance the financial reporting of long-duration contracts, by providing financial statement users with useful information in a timely and transparent manner.
Why is the FASB Making Targeted Improvements to the Accounting for Long-Duration Contracts?
Ten years ago, the FASB undertook a comprehensive project with the International Accounting Standards Board to improve the accounting for insurance contracts.
In 2013, the FASB issued proposed Accounting Standards Update, Insurance Contracts (Topic 834), which introduced new accounting models and qualitative and quantitative disclosures.
The feedback received from investors, analysts, insurance companies and other stakeholders overwhelmingly supported making targeted improvements to the existing insurance accounting model (instead of introducing a completely new and complex accounting model) and limiting the scope of insurance accounting to insurance companies.
What Kind of Outreach Did the FASB Undertake?
Over the past 10 years, the FASB has conducted extensive outreach activities and received significant input from a wide variety of stakeholders. The outreach activities undertaken by the FASB are depicted below:
Who Will Be Affected by the Changes?
The changes will apply to insurance companies that issue long-duration contracts such as life insurance, disability income, long-term care and annuities. The changes do not apply to policyholders.
How Will the Changes Improve Insurance Accounting?
The changes will result in the following improvements:
- A more current measure of the insurance liability. The liability for future policy benefits for traditional and limited-payment contracts will be regularly refined for actual experience and updated future assumptions. Also, the liability will be discounted at an upper-medium grade (low-credit-risk) fixed-income instrument yield that reflects the characteristics of the liability rather than the invested assets supporting the liability.
- Cash flow assumptions will be reviewed—and if there is a change, updated—at least annually, with changes reflected separately in net income.
- Discount rate assumptions will be updated at each reporting date, with changes reflected in other comprehensive income.
- A more uniform and current, market-based measure of market-based options or guarantees. Market risk benefits will be measured at fair value, with the effect of changes in the insurance entity's credit risk recognized in other comprehensive income.
- Simplified amortization of deferred acquisition cost. Deferred acquisition costs will be amortized on a constant-level basis over the expected life of the contract. As a result, the expense pattern will be more easily predictable and will no longer fluctuate in tandem with an insurance company’s investment or underwriting performance. Also, deferred acquisition costs will not be subject to impairment testing; instead, deferred costs will be amortized as long as the related contracts remain outstanding.
- Enhanced disclosures. Several new disclosures will be required, including liability rollforwards and information about significant inputs, judgments, assumptions and methods used in measurement.
When Will the Changes Be Effective?
For calendar-year public business entities, the changes are effective at the beginning of 2021. For all other calendar-year entities, the changes are effective at the end of 2022. Early application is permitted.
What About Transition?
Changes to the liability for future policy benefits and deferred acquisition costs will apply to all outstanding contracts on the basis of their existing carrying amounts at the beginning of the earliest period presented, adjusted for the removal of any related amounts in accumulated other comprehensive income. An insurance company will have the option to apply the changes retrospectively (with a cumulative catch-up adjustment to the opening balance of retained earnings), using actual historical experience information as of contract inception. This option will be elected at the issue-year contract aggregation level and applied to all contract groups for that issue year and all subsequent issue years.
Market risk benefits will be measured at fair value at the beginning of the earliest period presented. A cumulative catch-up adjustment will be recognized in two pieces:
- The cumulative effect of the effect of changes in the insurance entity’s credit risk will be recognized in accumulated other comprehensive income.
- The difference between fair value and carrying value, excluding the effect of credit risk changes, will be recognized in the opening balance of retained earnings.